Norris Co. has developed an improved version of its most popular product. To get this improvement to the market, will cost $48 m
illion and will return an additional $13.5 million for 5 years in net cash flows. The firm’s debt-equity ratio is .25, the cost of equity is 13 percent, the pretax cost of debt is 9 percent, and the tax rate is 30 percent.
What is the net present value of this proposed project?
A) $989,760
B) $1,102,459
C) $1,214,318
D) $1,077,180
E) $1,306,411
What is the net present value of this proposed project?
A) $989,760
B) $1,102,459
C) $1,214,318
D) $1,077,180
E) $1,306,411
1 answer:
Answer:
The NPV of the project is $1,077,180. So option D is the correct answer.
Explanation:
The cash flows from the projects are of the same amount and occur after equal intervals of time for a defined period of 5 years. Thus, they can be treated as an annuity. The net present value is the present value of future expected cash flows less the initial cost of the project. The NPV is calculated using the following formula,
NPV = Present value of annuity of Cash flows - Initial cost of the project
The amount of total assets using debt to equity is,
Total assets = Debt + Equity
And for every 1$ of equity, there is $0.25 of debt. Thus, total assets are,
Total assets = 0.25 + 1 = 1.25
The weightage of debt = 0.25 / 1.25 = 0.2 or 20%
The weightage of equity is = 1 / 1.25 = 0.8 or 80%
To calculate the present value, we will the formula for ordinary annuity cash flows as shown in the attachment. The discount rate used will be the WACC.
WACC = 0.2 * 0.09 * (1-0.3) + 0.8 * 0.13
WACC = 0.1166 or 11.66%
We use the after tax (1-tax) cost of debt in WACC calculation.
NPV = 13.5 * [(1 - (1+0.1166)^-5) / 0.1166) - 48
NPV = $1.077 million or $1,077,179.716 rounded off to $1,077,180
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Answer:
A. The first scenario where all three workers spend all their time mowing lawns,
In 10 hours = Larry mows 10 lawns, Moe mows 10 lawns, and Curly mows 20 lawns = (<em>Total is 40 lawns mowed, and 0 cars washed</em>)
B. The second scenario where all three workers spend all their time washing cars
In 10 hours = Larry washes 10 cars, Moe washes 20 cars, and Curly washes 10 cars = (<em>Total is 40 cars washed, and 0 lawn mowed</em>)
C. The third scenario where all three workers spend half their time on each activity then;
In 5 hours for mowing lawns and 5 hours for washing cars we get:
Larry mows 5 lawns and washes 5 cars
Moe mows 5 lawns and washes 10 cars
Curly mows 10 lawns and washes 5 cars
<em>In total they mowed 20 lawns and washed 20 cars</em>
D. The fourth scenario, Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns.
Larry mows 5 lawns and washes 5 cars
Mow washes 20 cars
Curly mow 20 lawns
<em>In total, 25 lawns will be mowed and 25 cars will be washed</em>
When this is plotted, the production frontier would produce a bow out shape, which is as a result of opportunity cost.
From the diagram, it can be clearly seen that Scenario C is inefficient because it is possible to mow more lawns and also wash more cars without actually reducing the production of others to 25 each.
Yes C is inefficient because more lawns can be mowed and more cars can be washed by simply just reallocating time of the 3 workers.
Explanation:
